Investing

Gold Sell-Off Is Buying Opportunity For Long Term Investors

Exciting vaccine news by Pfizer has pushed precious metals down, especially gold sees safe-haven demand drop heavily under new risk-on sentiment on financial markets. However, long term catalysts for gold have not changed.

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After months of gains for precious metals, both gold and silver have consolidated recently. Despite a recent spike in prices due to hiked stimulus expectations following the Democratic win, gold sees their biggest red day since the start of the corona crisis. While recent job reports showed a sign of dropping unemployment numbers, long-run unemployment levels have been rising despite numerous efforts by the U.S. government to support businesses and prevent permanent lay-offs. As more and more temporary furloughs turn into permanent lay-offs investors should be cautious and not get too excited, see Figure 1.

Figure 1 – Permanent job losses are on the rise

New Money Market Theory Leads To Unsustainable Quantitative Policy By Central Banks

The following chart explains why The Golden Investor stays long on gold despite today’s large sell-off. The following point has been made numerous times on The Golden Investor, but is very important: In Mid-2019 the Federal Reserve had to drop their Federal Funds Rate after they started the quantitative tapering to reverse and validate their quantitative easing policy during the last crisis. This sudden change in policy shows that there is a systematic problem with the way the Federal Reserve handles crises using their quantitative easing tools. The current corona crisis has triggered even larger asset purchases which very likely won’t be reversed in the corona aftermath. Every crisis initiates large short term shocks and shivers the economic engine for years through debt burdens created by the crisis. This is the reason that the FED only saw the opportunity to taper their balance sheet ten years after the initial shock in 2008. With larger debt burdens, higher levels of globalization and worldwide economic trouble this crisis has the potential to have its effects last even longer. Many companies are on the verge of collapsing and despite recent vaccine news, a real economy is far from reality.

Figure 2 – Money Market Theory is unsustainable

Two things are certain, especially following the recent FOMC meeting, interest rates are not likely to rise on the short term and the balance sheet of the FED is more likely to grow further, as Jerome Powell emphasized that the FED’s ammunition is far from empty. Along with the Democratic win there is a higher chance of even larger amounts of governmental support which could blow-up the U.S. deficit even more. These long-run catalysts have not changed, therefore The Golden Investor argues that the current drop in gold prices is a buying opportunity for long term investors.

Gold Price Dynamics Over The Last Two Years

To be able to understand the long term potential of gold, recent gold price dynamics should be considered. The latest bull run has been the fastest since the aftermath of the financial crisis in 2008, when the gold price rose from a low of around 800 USD to an all-time-high of 1800 USD. In the following chart the most recent bull run is plotted along with the VIX-curve, which is an indicator for volatility that uses short term option prices to index volatility. The index uses an overweight of put options to calculate volatility and therefore has a tendency to only display downward volatility.

Figure 3 – Gold Price Dynamics

Gold Price Dynamics Time-Line

  • 1 – June 2019 – The Federal Reserve announced it would drop interest rates for the time and stop its quantitative tapering immediately. The FED ended up cutting their interest rate two more times that year in a reaction to signs of a suffering economy after initial interest rate hikes. A sign that showed that the economy was not as robust as expected.

  • 2 – December 2019 – Several PMI levels had been underperforming for six months in a row underlining the economic damage caused by increasingly nervous financial markets suffering under trade-war tensions. At the same time an unexpected attack on the Iran general Qasem Soleimani near Bagdad Airport pushed tensions and gold prices higher.

  • 3 – February 2020 – Markets saw their first losses related to exponentially growing numbers of corona cases in Italy. The following spread over Europe and the United States triggered the first large scale sell-off since the last financial crisis. The VIX-index spiked, while the sell-off triggered a sell-off in gold too.

  • 4 – March 2020 – The Federal Reserve dropped their interest rate to zero and initiated their largest asset purchases in history. In the following months and several lockdowns further it became clear that this crisis would last longer than one initial wave.

  • 5 – July 2020 – As financial markets saw a V-shaped recovery and stocks seemed expensive, a new influx of funds through ETF’s was flowing into gold assets. Combined with new waves of corona outbreaks and resulting lockdowns, safe-have demand pushed the gold price to an all-time high.

Currently we are at point 6 and Pfizer has announced to have a very effective vaccine. Despite losing a large one hundred USD in one day, financial fundamentals remain strong for gold. Considering that new stimulus packages are necessary to support struggling businesses and a fast and effective roll-out of the corona vaccine is far from certain, there are still many uncertainties going into 2021. Furthermore, it is important to note that mutations through animals could pose a threat to current vaccine trials and pose significant dangers to the total world economy, especially since markets and governments have put their hopes on a vaccine-resolved economic crisis. There is a widespread misunderstanding of the severeness of the created debt burden that is likely to hit governments and businesses hard the coming years. A new drop in economic activity could pose a threat to real recovery, the only savior in such a scenario is the central bank, but their aggressive approach is a feast for definancialized cryptocurrencies and safe-haven assets like gold and silver. There is no end-game when interest rates are stuck at zero.

The narrative of The Golden Investor has been the same for months, however now there is the evidence that there is truth in The Golden Investor’s gold price dynamics analysis. On the short run a second sell-off could trigger new losses to gold assets, however since markets tend to be completely distorted due to excessive central bank liquidity, large sell-offs won’t pose an immediate danger to gold assets. And after gold prices will settle to a new level, The Golden Investor will try to balance more weight into gold assets again. However, currently a balanced portfolio with more weight to cash assets could be wise. There could come a major shift from tech-assets back to value assets as financial markets re-balance towards a normal economy. At 24 USD/oz. silver looks cheap, as silver demand is partly driven by industrial demand, silver assets could outperform gold on the long run. The Golden Investor expects gold and silver miners to double in value over the course of the next year, many miners have already reported huge increases of free cash flow. Time will tell if The Golden Investor is right, or if the global economy will prove to recover unexpectedly fast.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.

Bibliography

  1. https://fred.stlouisfed.org

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